Municipal Bond Fund ‘Swan Dive’

Investors have traditionally bought municipal bond funds for income purposes. The tax-exempt status provides real appeal and the default rate on municipals has always been exceptionally low. Against that backdrop, ‘munis’ have always proven to be less volatile than equities and many other sectors of the bond market . . . until now.

If a picture tells a thousand words, this graph of a Nuveen National Municipal Closed End Fund (NXR) is more than a short story. From the Sense on Cents link to The Wall Street Journal’s Market Data page, we learn:

That cliff-like drop on the right side of the graph represents approximately a 7% decline in the value of this specific fund culminating in a precipitous 5% drop just yesterday. Part of the decline is explained by the fact that yesterday this fund traded “ex-dividend,” meaning that investors who purchased the fund yesterday are not in line to receive the October dividend. That dividend represents a minor part of the overall decline in the value of this fund.

What does the decline truly represent? The fact that bonds in this $185 million fund declined in value. Why would that happen? The municipalities which had issued these bonds are likely having problems refinancing their debt. What does that mean? Those municipalities will be forced to pay higher rates. And what does that mean? Their outstanding bonds, such as those in this national fund, decline in value. Additionally, the higher rates mean the municipalities will remain hard pressed not to cut services and employees.

Keep your brokers and financial planners honest and compel them to fully explore the credit quality of investments (whether bonds or equities) prior to investing. Otherwise, picture yourself as having invested in this fund a month ago and now eating a 7% loss as you take a ’swan dive’ off the right side of the above graph.

Disclosure: No position in NXR

Comments

[GoochyPuppy:]

Tax free muni's at over 6% (before tax advantages), are a tremendous value for scaling into with a 5 to 10 year time frame.

Oct 14 03:13 PM

[Analyste de...:]

I don't find the case for holding this CEF compelling. A fund for a major asset class with $185mln may liquidity issues, if one large institutional client represents 15% of assets. Against that risk, a larger muni mutual fund might be a preferable alternative!

For etfs, (TFI) and (MUB) look less volatile and less expensive, but the yield lower too. So is (NXR) worth the extra 100bps income, in this environment? If it is, you accept the greater volatility.

Big picture? The risk-return of these types of fixed income instruments needs to be reassessed, unfortunately. None of these investments, nor (AGG) for that matter, have kept up with REAL inflation in the last 24 months. Check John Williams' Shadow Stats. If you're not making >9.2% annualized TR, you're losing to inflation. Easy Al and now Helicopter Ben have created this monster: investors get pushed further out on the risk-return curve or see erosion in their investments' real value.

For munis, Yields must rise! Who's buying? I don't think we're fairly compensated for the risk, now.

Oct 14 03:20 PM

[CoverIsBetter:]

If you averaged down on the funds about six months ago (estimated) this "Swan Dive" is not going to hurt so bad. Like, Goochy said, this is a long term investment.
That said, I dumped all of my EVN shares this AM, because I just can't put up with erratic "swan dives" while licking my wounds in the real estate market at the same time. I will be back to Eaton Vance however. 8% dividend tax-free + share price appreciation = winner to me.

Oct 14 04:44 PM

[alenow:]

Year end tax selling is to be expected with muni CEF's...it happens most years. And it went ex-dividend as mentioned....no big deal if one is a long term income investor in this asset class.

Oct 14 04:51 PM

[F. Bradeen:]

Another Muni CEF, symbol MFL, had the same market decline over the last 4 or 5 days. This action may not be fund specific.

Oct 14 05:38 PM

[Kenneth Fin...:]

This is the nature of the beast in the closed end fund space. Use these sell-offs to re-evaluate your closed-end fund posiitons, keep your powder dry as there is more of this to come in 4Q.

Oct 15 08:44 AM

[oldman:]

I hold several Nuveen Muny's over 9 months and I see that many have taken the nice appreciation made but I have not. First of all I don't have long term gains and I bought them for income and a money market alternative, so I'm happy. A few have increased distributions. And where else can you get 6-7% with AA and higher.

Oct 15 09:17 AM

[lower98th:]

I really loved my NC Municipal Power Bonds at 13% (circa 1980's). And they weren't called for years after rates went lower. Never say never.

Oct 20 06:53 PM